Explained | How will Sri Lanka overcome its debt crisis?

Will assistance from the International Monetary Fund be enough to restructure loans and rescue the economy?

The story so far: On April 12, Sri Lanka announced its decision to default on its foreign debt of $51 billion, tarnishing its track record of promptly servicing past loans. Citing the International Monetary Fund’s assessment that the country’s debt stock was “unsustainable”, the Finance Ministry said its policy of repaying foreign debt on time was “no longer tenable”. It described the default move as its “last resort” to prevent “a further deterioration” of the country’s financial position, and to ensure fair and equitable treatment of all creditors. In the coming week, Sri Lanka will hold talks with the International Monetary Fund (IMF) in Washington DC, on a comprehensive debt restructuring programme.

Sri Lanka is experiencing one of its worst economic crises. For months now, households and businesses have had to cope with severe food and fuel shortages, while the government scrambles for dollars to pay for essential imports. Emergency financial support coming in, including from India, is barely enough to sustain the country for a month. With authorities sharing no roadmap or plan, fears of hunger and starvation are growing, and thousands of people have been voicing their anger against the government. Amid mounting protests, the government took two major decisions recently — to default on the country’s debt, and to seek IMF support to restructure outstanding loans and rescue its teetering economy.

No middle-income country other than Sri Lanka has resorted to a debt default in recent years. Usually, creditors and investors see a defaulting country as less favourable for business. This makes it harder for the country to borrow from external sources. If domestic production is low, as is in Sri Lanka’s case, it is even harder to cope.

All the same, Sri Lanka’s pre-emptive default takes away the pressure of having to repay some $7 billion in debt this year, giving the country some time to stabilise. Further, the default move came just ahead of Colombo’s scheduled talks with the IMF, on the sidelines of the Spring meetings of the Fund and World Bank, beginning in Washington DC on April 18. The IMF is expected to come up with a package that will allow Sri Lanka to restructure its external debt over time. Such a programme, including immediate relief of a couple of billion dollars, will also make Sri Lanka more credit worthy in the international money market.

Citizens are finding it very difficult to source essentials, including cooking gas and kerosene. Fuel is in short supply and is now being rationed to customers after long periods of waiting in queues. Costs of all basic commodities have risen sharply making them unaffordable for most. Colombo is sourcing fuel and food supplies for the month using external help, including credit lines from India.

From the time Sri Lanka’s economic meltdown intensified this year, President Gotabaya Rajapaksa’s government has been facing considerable pressure from citizens, who have been unrelenting in their call for the resignation of President Gotabaya Rajapaksa and Prime Minister Mahinda Rajapaksa. Although the Cabinet resigned en masse, neither of the ruling brothers — who the public hold chiefly responsible for their suffering — appear inclined to step down. Meanwhile, shortages persist, and prices soar, putting people through enormous hardships. Even after the government announced its decision to suspend debt servicing and seek IMF aid with an accompanying structural reform package, it is yet to restore any confidence among the general public, going by the large demonstrations that continue.

The way forward is neither easy nor straightforward for Sri Lanka, even with IMF assistance. Senior Sri Lankan economists have observed that the situation would likely get worse before getting better, and that there could be no gain without pain. Much would depend on the conditions imposed by the IMF and how Sri Lanka responds to them, given the government's political compulsion to regain lost ground. It is widely predicted that the Fund’s recommended reforms would include greater taxation, and a reduction in state spending. What this could mean to the average citizen reeling under the shock of this economic calamity remains to be seen. It would be especially challenging for the Rajapaksa regime, which has lost significant political capital in the wake of this crisis, to make and implement tough policy decisions that would be inevitable at this time.